Will Arch Coal be a Hot Stock in 2013?

With shares of Arch Coal (NYSE:ACI) trading around $7.65, is the company an OUTPERFORM, a WAIT AND SEE, or a STAY AWAY? Let’s analyze the stock with the relevant sections of our CHEAT SHEET investing framework:

C = Catalysts for the Stock’s Movement

Observers who have turned their eyes overseas for coal-industry growth prospects know that China’s average manufacturing PMI for the past 12 months has been just 49.1, signaling a contraction. China’s GDP for 2012 was just 7.5 percent, a far cry from the 9.7 percent seen in 2011. With the boom of the North American natural gas industry (and an unfavorable regulatory environment in the U.S.) many coal companies have looked hopefully across the Pacific.

China’s December manufacturing PMI registered 51.5, indicating growth heading into 2013. HSBC’s chief economist for Greater China commented on the reading: “Such momentum is likely to be sustained in the coming months when infrastructure construction runs into full speed and property market conditions stabilise.”

E = Equity-to-Debt Ratio is Not Close to Zero

Arch Coal’s debt-to-equity ratio of 1.45 puts it at the bottom of the pile when compared against its competitors. Peabody Energy (NYSE:BTU) clocks in at 1.07, while Alpha Natural Resources (NYSE:ANR) looks relatively attractive at just 0.59.

It’s also important to consider total debt and total cash on hand, which for Arch Coal is $4.58 billion in debt and $650.11 million in cash. Peabody has $6.36 billion in debt and $648 million in cash, while Alpha has $2.99 billion in debt and $549.4 million in cash.

Since the beginning of 2013 the stock price has been in an upward trend, rising 4.51 percent this year to date, but falling 43.38 percent year over year.

As a benchmark, the S&P 500 has risen 4.19 percent year to date, and 13.60 percent year over year. ACI has managed to outperform one of its major competitors, Alpha Natural Resources.

T = Trends Support the Industry in which the Company Operates

There are plenty of estimates floating around about the future of the coal market. Peabody Energy expects global coal demand to grow 12.6 percent by 2016, with 70 percent of the new demand coming from China alone. China is expected to open nearly 130 coal-fired power plants by 2016, and India, which relies on coal for at least 55 percent of its electric power, is expected to open more than 40 more. By 2035, global coal use is expected to increase 50 percent, according to the World Coal Association. Demand for metallurgical coal used in steel production is also expected to ramp up as rapidly industrializing economies in Asia invest in infrastructure.

What’s more, coal’s share of the global energy mix will come close to surpassing oil as the world’s top energy source by 2017, according to the International Energy Agency’s annual Medium-Term Coal Market Report. “Although the growth rate of coal slows from the breakneck pace of the last decade, global coal consumption by 2017 stands at 4.32 billion tonnes of oil equivalent (btoe), versus around 4.40 btoe for oil, based on IEA medium-term projections,” states a release for the report.

However, it adds that “coal demand will increase in every region of the world except in the United States, where coal is being pushed out by natural gas.” This decline in North American coal use is evident by the long-term stock movement of coal companies.

Conclusion

Coal’s future seems to hinge on its overseas success. In North America, the shale gas revolution is expected to all but eliminate the resource from the energy mix. New regulations make it almost impossible to open up new coal-fired power plants, and social and economic trends favor the cleaner, cheaper natural gas.

Because of this and the metrics above, Arch Coal is a WAIT AND SEE. Speculation is fine and dandy, but the company will need to prove it can turn earnings around before seeing sustained stock price growth.